The two most popular types of bank loans in present day banking services in Nigeria, these are loans and overdrafts. Other forms which may not necessarily take the shape of a loan account or an overdraft account include discounting trade bills, negotiating bills on letters of credit as confirming bank, or investing in equity stocks and gilt-edged securities.
Whatever form of lending is adopted in any given case depends on the purpose of the borrower and the circumstance of the transaction. The important thing to understand is that regardless of the form a bank lending takes, a debt is inevitably created between the bank and the customer. The bank becomes the creditor and the customer the debtor.
In order to facilitate assessment and classification of propositions, banks have their own printed forms of application. Written applications are sometimes admitted in the form of letters too. There is an advantage in obtaining application for bank advances in writing, since it helps in determining the relationship between the bank and the customer as a borrower, and also constitutes a concrete and verifiable record of the customer’s intention in making transfers that creates the overdraft or loan.
However, it is not always necessary or possible to obtain a formal application from a customer before lending. Many a time, the banker approves a customers transfer even though the account will be overdrawn as a result, if from his knowledge of the customer and from the character of the account being overdrawn he considers the customer both trust worthy and credit worthy.
It has been started earlier that a debit is created between the bank and its customer, whether the borrowing is in the form of a loan or an overdraft. The form is only a matter of administrative convenience.
A loan is processed as a separate account of its own, whereby the whole sum granted to the customer is released in a lump, all at once. After the initial drawing which creates the loan, no further drawing is allowed on the account. The subsequent entries that pass through the account are the interest charges and the repayment installments. The interest charges will have the effect of increasing the amount of debt outstanding on the account. On the other hand, repayment installment will reduce the debt steadily until the whole debt is fully repaid. However, most banks prefer to limit entries in a loan account to the initial debit creating it and the subsequent repayment installments, while interest charges due from the loan are debited to the borrower’s current account. This method makes for easy administration of loan account but may not be advisable, where the current account is already in bad state and without any security attached to it.
Loan accounts are most suited for personal and professional borrowing. Some industrial borrowing also fit in best under a loan account scheme, for example, borrowing for purchase of expensive machinery. In fact, there is no hard and fast rule about it. Much depends on the sources of repayment, the agreed method of repayment, and how the borrower wants to disburse the money. Where, for instance, a customer needs a ₦10 000.00 advance to pay for a series of consignment that would be spread over three months, it would be unwise for him to take a loan of ₦10 000 instead of an overdraft of the same value. A loan would be unwise because he would have to pay interest charges on the whole ₦10 000 Loan even for the period he did not actually spend some parts of the money, while waiting for the goods to arrive.
An overdraft is usually created on a current account. Unlike a loan account where only periodical payments are made, an overdraft account. Drawings and deposits are made on the account as frequently as funds are needed or received in connection with the business to which the account relates. For instance, an overdraft account used purely for retail trading purposes receives deposits rather frequently and usually in small sums, drawings also tend to be frequent as the customer draws money required for paying for goods bought for sale. Whereas, in the case of financing a building contract, for many weeks or even months running, the account may not receive any deposit. Drawings on such an account will usually tend to be frequent in payment for building materials and labour. Deposits will rather be heavy and at long intervals, on release of stage payments to the contractor.
In an overdraft account, the whole or part of the amount granted may be released at a time, according to the customer’s needs. A part or the whole sum may be repaid and re-borrowed many times over and again, without consultation during the currency of the overdraft arrangement.